Demonstrators outside Russian-owned VTB Capital bank in London last week call for the UK government to impose sanctions. Photograph: Ruth Whitworth/Demotix/Corbis

The reaction of the financial markets to the west's sanctions over Crimea spoke volumes. Up went the rouble and shares on the Moscow stock market, down went the price of crude oil.

Conclusion: the steps announced by the US and the EU were seen as a slap on the wrist for Vladimir Putin, the very least that could be delivered without Barack Obama, Angela Merkel et al all losing face.

True, the door was left open for a ratcheting up of sanctions in the event that the Kremlin continues to "destabilise" the situation in Ukraine. But this was a weaker response than the markets had been expecting, not just in the number of people targeted by sanctions (21), but in their second-rank status and the limited nature of the visa restrictions and asset freezes.

Significantly, the west did not target Putin and his immediate entourage. Neither did the sanctions include the oligarchs who have their wealth salted away in London, New York and other financial centres in the west.

Compared, for example, with the sanctions imposed on Iran – which have frozen oil assets, targeted exports of petroleum-related products and crippled the banking sector – the measures announced following the snap referendum in Crimea are mild.

There are two possible explanations for this approach.

The first is that the west thinks that a modest package of measures is the best way to defuse the crisis, and hopes that Putin will back down at the first whiff of grapeshot.

The second is that there is no real appetite for a tougher approach: London and Manhattan are awash with Russian money; Germany's need for Russian gas is stronger than ever now that nuclear power is on its way out; the struggling French economy can ill-afford the loss of lucrative defence contracts with the Kremlin.

Without doubt, the west could cause serious harm to what is already a shaky Russian economy. Growth slowed markedly during 2013 and is over-dependent on the oil and gas sector.

Researchers at Capital Economics, a London-based consultancy firm, estimate that $50bn (£30bn) of private-sector money has flowed out of Russia since the start of 2014, and if this trend were to continue the economy would be pushed into recession.

An escalation of the crisis in Ukraine carries real economic risks for Moscow, particularly if the west responds with export curbs and banking restrictions. As Iran has shown, sanctions work if they are stringent enough.

That, though, is not the issue. The west's problem is that it cannot hurt Russia without hurting itself, and fears the consequences of the mutually assured destruction which might follow if the Kremlin were to order the tanks in.

Over and above the lost contracts and the threats to energy supplies, Obama, Merkel, François Hollande and David Cameron are all acutely aware that a Russian invasion of the Ukraine could derail their fragile recoveries.

Putin knows that too. Which is why the message from the west – these sanctions might not hurt you, but tougher sanctions would – will not have the Russian leader quaking in his boots.